A Short Guide to Individual Savings Accounts (ISAs)

Below, we explain how an ISA works and why you might want to consider including it in your financial plan.

How do ISAs Work?
An ISA is a type of savings or investment account with certain tax advantages. The main features are described below:

• You can contribute up to £20,000 per year to ISAs. If you don’t use your allowance, you can’t carry it forward to a future year.
• Any income or growth on your account is free of tax.
• You can normally make withdrawals at any time from your ISA without tax or penalty.
• Any money that has been withdrawn can be replaced in the same tax year without using up any of your ISA allowance. However, not all providers allow this, so it’s important to check the terms and conditions.
• You can transfer your ISA to a different manager and switch between cash and stocks and shares if you wish.

Cash or Stocks and Shares?
You can invest your ISA in cash, stocks and shares, or a mix of both.

If you choose cash, the value won’t fluctuate with the market, and you won’t have to worry about losing money during a downturn. However, any interest paid is likely to be below inflation, which means your money will be eroded by the increasing cost of living.

A cash ISA can be a good option if you are likely to need access to the money in the next few years.

Stocks and shares offer higher potential growth over the long term, but this greatly depends on the investment option you choose. Your investment will rise and fall depending on the underlying assets.

Considerations include:

• How much risk you can or should take with your investment.
• Diversifying your assets so that you are not concentrating too much in any one area.
• Charges for fund management, platform administration, and advice if required.

There are various online tools to help you decide how to invest your ISA. Alternatively, a financial adviser can recommend a suitable portfolio for you.

Lifetime ISAs
If you are saving for your first property, you might want to consider a Lifetime ISA (LISA) for some of your allowance. You can open a LISA if you are between 18 and 40, and if you already hold one, you can continue making contributions until age 50.

You can pay in up to £4,000 per year, and will receive a 25% credit (up to £1,000) from the government.

You can use the money on a property deposit providing it is your first home, it costs under £450,000, and you complete the purchase at least 12 months after your first LISA contribution.

If you don’t use your LISA for this purpose, you will need to wait until at least age 60 to take the money out penalty-free. Earlier withdrawals incur a penalty of 25%.

What Happens When You Die?
If you have a spouse or civil partner, they can claim an ‘additional permitted subscription’ (APS) in the event of your death. This means that they have an additional contribution allowance equivalent to your ISA value as of date of death.

It’s commonly stated that ISAs can be passed to spouses on death, and while this is technically true, there are a couple of additional points to bear in mind:

• It is the value that is transferable, not the pot itself, although the surviving spouse can choose to use the original ISA to fund their APS. Alternatively, they can make a cash contribution.
• If the value has increased since the date of death, they may need to use their own ISA allowance, have some of the proceeds paid as cash, or transfer the assets into a non-ISA account (if the provider allows this).

ISAs form part of a person’s estate for Inheritance Tax (IHT) purposes and may incur tax on death.

Some investors use their ISA to invest in smaller companies, i.e. those listed on the Alternative Investment Market (AIM). These shares can qualify for business relief, which offers a 100% exemption from IHT providing they are held for at least two years and are still held at the time of death.

Are There Any Downsides?
If you are planning to save or invest, there are no major disadvantages to using an ISA. They are both tax-efficient and simple to administer.

However, depending on what you use them for, there are a few potential issues to look out for:

• Cash ISAs often pay lower rates of interest than standard savings accounts. As you may be able to use your savings allowances to reduce or eliminate tax on your cash savings, it might be more efficient to hold cash outside an ISA.
• Stocks and shares ISAs are subject to risk and volatility, just like any other investment. Your ISA may lose money if you invest in speculative assets. However, even a well-diversified portfolio will rise and fall with the market – taking money out during a downturn can also erode your returns.
• ISAs are limited by the annual contribution allowance. If you have a lump sum to invest, you may need to consider other options in addition.

Other Options
Depending on your situation, the following options might also be beneficial, either instead of or in addition to an ISA:

• Before you start to consider investing, you should make sure you have an adequate emergency fund, enough financial protection, and that you have cleared any expensive debts.
• Pensions offer even more tax benefits than an ISA, however, they are also more restrictive as you can’t access the money until at least age 55. A sensible financial plan will normally include both.
• Investment accounts work in a similar way to a stocks and shares ISA, although without any particular tax benefits or restrictions. Income tax and capital gains tax may apply. An investment account is often the next step if you have already used your ISA and pension allowances.
• Investment Bonds can be tax-efficient if you wish to invest a lump sum for the long-term, particularly if you are likely to gift the investment or place it in trust.
• If you are looking to boost your cash balance, it’s worth looking at easy access accounts, notice accounts, term deposits, Premium Bonds, and other NS&I investments as well as cash ISAs.

If your financial situation is complex, it may be worth speaking to a financial adviser to determine how an ISA could fit into your financial plan.

Please don’t hesitate to contact a member of the team if you would like to discuss your investment options.